Written by Dale Roberts
Friday, October 25th, 2019
A balanced portfolio is an investment that combines stocks and bonds. Stocks are the growth engine of the portfolio and allow us to become part owners of companies. Bonds are in the portfolio to manage the risks of the stocks and stock markets.
In a sense, the stocks play offense and the bonds are on defence.
A portfolio needs those bonds to be considered a balanced portfolio. The bonds can provide ballast for the stocks—they work like shock absorbers, since they tend to perform well when stocks don't. And bonds allow us to dial up or dial down the risk level.
For example, if we were to see a major stock market decline of 50%, here's how levels of balanced portfolios could potentially react:
- A portfolio with 20% stocks/80% bonds = down 10%
- A portfolio with 50% stocks/50% bonds = down 25%
- A portfolio with 75% stocks/25% bonds = down 35%
Portfolio rebalancing means moving money from stocks to bonds, or from bonds to stocks as the value of each of these holdings fluctuate. This rebalancing returns the portfolio to its original mix.
For example, if you hold a portfolio with an intended asset mix of 60% stocks and 40% bonds, and then the stock markets go on a tear, 70% of your portfolio's value could consist of stocks and 30% of bonds. That means it's time to rebalance. Enough of the stocks would be sold (10%) and the proceeds would be used to buy bonds to bring the portfolio back to 60/40.
This will also keep your risk level in check. That 70/30 portfolio was holding more stocks and risk than your initial 60/40 portfolio. The risk level had drifted.
Buy Low and Sell High, Right?
We've all heard that famous investment mantra. Simple rebalancing in a portfolio is often a form of buying low and selling high. We're selling assets that have done well and move the funds to what's considered an underperforming asset.
Since stocks often outperform bonds over the long term, it usually means taking the winnings from the riskier stocks and moving them to the less risky bonds.
What Else is in a Balanced Portfolio?
In the name of diversification, a balanced portfolio will typically hold Canadian, American and international companies.
At times, we need to bring the geographic allocations bank into balance. Over the last several years, that has meant selling the better performing American stocks and moving the funds to Canadian and international stocks. At times, this can find hidden value, since we're buying the stocks at lower prices.
You Can Rebalance or Go With a Managed Portfolio
You might hold individual low cost funds. In that case, you or your advisor would do the rebalancing. But you can also use complete managed balanced portfolios that will do the rebalancing for you. Those options can come by way of low cost mutual funds, Robo Advisors or complete one-ticket asset allocation portfolios.
A balanced portfolio can offer complete diversification at your risk level of choice.